Monday, December 11, 2006

DHB strikes are an old socialist joke

How much are nurses, radiologists and med-lab workers worth? How about teachers? Or headmasters?

It's impossible to know. It's impossible to know for sure since there is no market for these activities, and so there's no way (beyond extraolating from the markets for other activities) to set accurate and aggreeable prices for these ones. In the absence of a successful market to set the prices, intense political activity (including strikes) is undertaken to set such prices -- the prices eventually set are at levels deemed politically acceptable (ie., that minimise negative headlines) rather than economically appropriate (ie., either affordable, or economically justified).

This is not a trivial point. In fact, the point is so important it explains the collapse of the Soviet Union.

The point itself is captured in an old Soviet joke, which goes as follows: The Soviet Union has invaded and successfully conquered every country on the planet, with one exception: New Zealand. The Soviet Union has chosen not to invade New Zealand. Question: Why? Answer: So we would know the market price of goods.

The point is known as socialism's calculation problem -- it explains the economic reason that socialism did not work, and it explains too why Russian cow sheds, factories and the subways of Moscow were lined with marble while old women sat outside subway stations selling used bars of soap -- used bars -- so they could eat; why Eastern European 'planners' assiduously scanned western futures markets for prices, which were then translated into rubles and scanned into bilateral clearing accounts; and it is why even today publicly-owned services around the world continually erupt in disputes and strikes over pay: for in a socialist (ie., publicy-owned) system there is no way of setting the value for such services, so such disputes become the chief way in which pay is set. The squeaky hinges will get the oil (unless of course the squeaky hinges are silenced by force, as they were in more repressive regimes!).

But the uniqueness and the crucial importance of Mises's challenge to socialism is that it was totally unrelated to the well-known incentive problem [ie., why would people produce when their income is supposedly guaranteed, when talent is unrewarded or error unpunished?]. Mises in effect said: All right, suppose that the socialists have been able to create a mighty army of citizens all eager to do the bidding of their masters, the socialist planners. What exactly would those planners tell this army to do? How would they know what products to order their eager slaves to produce, at what stage of production, how much of the product at each stage, what techniques or raw materials to use in that production and how much of each, and where specifically to locate all this production? How would they know their costs, or what process of production is or is not efficient?

Mises demonstrated that, in any economy more complex than the Crusoe or primitive family level, the socialist planning board would simply not know what to do, or how to answer any of these vital questions...

A complex market is simply the sum of voluntary exchanges freely entered into by participants according to their own value estimates. Value in this context is measured by the value we each place on goods and services by freely trading what we have produced for things on which we place even greater value. This morning for instance I traded three dollars for a large container of milk, since I placed greater value on that milk than I did on those three dollars (and the dairy owner valued my three dollars more than she did the milk). A market is simply the sum of all such voluntary exchanges, and it is by the sum of all such transactions freely entered into by which prices are set. There is no other way to determine economic value. But such voluntary exchanges are either banned or impossible under socialism.

Developing the momentous concept of calculation, Mises pointed out that the planning board could not answer these questions because socialism would lack the indispensable tool that private entrepreneurs use to appraise and calculate: the existence of a market in the means of production, a market that brings about money prices based on genuine profit-seeking exchanges by private owners of these means of production. Since the very essence of socialism is collective ownership of the means of production, the planning board would not be able to plan, or to make any sort of rational economic decisions. Its decisions would necessarily be completely arbitrary and chaotic, and therefore the existence of a socialist planned economy is literally "impossible" (to use a term long ridiculed by Mises's critics).

They still don't know how today. And nor can they. It is still literally impossible, and if you aren't sure why it is, I challenge you to read and digest Rothbard's summary.

UPDATE: Canterbury Uni's Eric Crampton argues here (and in the comments below) that incentive played a greater role than did calculation in the collapse of the Soviet Union. Discussion ensues at his Econ Log article: Second Best and Soviet Calculation.

The calculation debate [says Eric] was framed entirely in the context of benevolent planners. And, when planners are benevolent, it's very clear that planner inability to engage in economic calculation reduces welfare in a planned economy. But what if the planner isn't benevolent?

2 Comments:

While I agree completely with Mises and Rothbard as to the impossibility of economic calculation under socialism, it isn't the calculation problem that caused Soviet collapse. Rather, it was the public choice problem of incentives. Strictly speaking, the calculation argument predicts an unbiased but high variance price vector: planners should err as frequently in overestimating prices as they do in underestimating them. We'd consequently expect as many instances of shortages as of surpluses at set prices, with planners then groping for equilibrium prices by changing prices after observing queue or stockpile. Instead, we tended to see more shortages at stated prices. David Levy first pointed this out; Andrei Shleifer discussed it further. Simply put, shortages allow lower level planners to extract rents from those in the queue.

Andrew Farrant and I elsewhere argue that, to the extent that the calculation argument is correct, it actually improves outcomes under socialism as compared to a situation where the planner remains self-interested but has the ability to set prices perfectly. In that case, the planner successfully and efficiently extracts all surplus from the citizenry. The working paper version of the article is available here ; further discussion of it is available at EconLog.

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Comments on this post

DHB strikes are an old socialist joke
While I agree completely with Mises and Rothbard as to the impossibility of economic calculation under socialism, it isn't the calculation problem that caused Soviet collapse. Rather, it was the public choice problem of incentives. Strictly speaking, the calculation argument predicts an unbiased but high variance price vector: planners should err as frequently in overestimating prices as they do in underestimating them. We'd consequently expect as many instances of shortages as of surpluses at set prices, with planners then groping for equilibrium prices by changing prices after observing queue or stockpile. Instead, we tended to see more shortages at stated prices. David Levy first pointed this out; Andrei Shleifer discussed it further. Simply put, shortages allow lower level planners to extract rents from those in the queue.

Andrew Farrant and I elsewhere argue that, to the extent that the calculation argument is correct, it actually improves outcomes under socialism as compared to a situation where the planner remains self-interested but has the ability to set prices perfectly. In that case, the planner successfully and efficiently extracts all surplus from the citizenry. The working paper version of the article is available here ; further discussion of it is available at EconLog.

There are a few Austrian fellow-travelers here at Canterbury...
Eric, you said: "There are a few Austrian fellow-travelers here at Canterbury..."

Great to hear. :-)

Feel free to guest-blog here any time. ;^)

In the meantime I look forward to getting to grips with your paper, and giving some thought to the discussions going on at Econlog.